TOP 5 TIPS FOR
The interests of investors and portfolio companies will often diverge when their company enters the zone of insolvency. Investor directors sitting on portfolio company boards need to remember that although they may be appointed to look after the interests of the investor, as directors they remain subject to director’s duties, which are paramount. Investor directors may need to navigate certain complexities that arise when their company is in financial difficulty.
It’s vital to properly record board discussions and the independence of the investor directors to refute any breach of duty and/or wrongful trading claims that may arise. It’s no good, when an administrator or liquidator, is filling the report on the conduct of directors, for directors
to say, “Well, I must have had good reasons to . . .”
Proper record keeping is imperative, particularly comprehensive board minutes of regularly held board meetings. These minutes will help evidence the directors, including the investor directors, complying with their duties and taking well-considered decisions, including the decision to continue trading (see more below).
Directors may disagree with decisions being taken, and those disagreements should be minuted. Where a director is not supportive of boards’ collective decisions they may consider resigning, however, resigning will not absolve the resigning director from liability so long as they have the power to influence the company making the right decisions. Investor directors, in particular, should clearly distinguish their own contributions to board business from input they have been asked to provide on behalf of the investor.
Failure to keep proper records can make answering breach of duty and/or wrongful trading claims much more difficult.
Conflicts or interests in transactions often arise with investor directors when any interaction with the investing entity is considered—these should always be declared and recorded.
Conflicts or interests in transactions often arise with investor directors when any interaction with the investor entity is considered and should always be declared and recorded. It is not uncommon during financial difficulties for investors to consider further investment to save the company, and the investor director will often play a vital role in liaising between the board and investor.
While the company’s articles might allow for interested directors to be present and vote at meetings, the interested director should carefully consider whether recusing and re-joining meetings at the appropriate time might be more prudent, as it allows the other directors the opportunity to have a more open discussion and reach a conclusion without any undue influence. Where directors do recuse themselves, they should remember to re-join the meeting for the reminder of the board’s business.
Investor directors also need to be mindful that they may receive confidential or non-public information during board meetings, which they may not be able to share with the investor.
Liquidity should be discussed at every board meeting. This allows directors to determine how long they can keep the company going, what the company’s funding needs are, the support an investor entity could provide, and when they could be in wrongful trading territory.
Liquidity should be discussed at every board meeting. Board members should be fully aware of the company’s financial challenges, its cash position, and possible upcoming liquidity pinches. This allows directors to determine how long they can keep the company going and when they could be in wrongful trading territory. For investor directors, liquidity updates may inform the investor’s decision on whether to make further funding available or not.
Directors will need to carefully consider whether additional financing should be taken and on what terms. Would the additional credit allow the company to navigate financial difficulties, or would the expenses incurred on reliance of
the new funding contribute to its balance sheet insolvency? When considering investment from existing investors, directors will need to consider if such funding is on competitive terms given the company’s situation, what alternatives are available, and whether the terms of the funding would force
the company to favour a particular creditor (such as the investor) or require extortionate repayments.
Where additional funding is unlikely to help steer the company away from its financial difficulties, directors should consider seeking insolvency protection rather than increase the company’s liabilities. For the company to incur new credit when the decision-makers know or are reckless as to whether the debt can be paid when due, will take those decision-makers into fraudulent trading territory. Great caution should be exercised, and appropriate advice should
Reasonable Prospect Test
Directors should consider and clearly record the basis on which
the directors believe it is reasonable to continue trading to avoid insolvency. Reliance, placed on the continued financial support of
the investor, should be genuine support.
Wrongful trading liability arises once a director or directors conclude (or should have concluded) that there is no reasonable prospect of the company avoiding an insolvent liquidation or administration, and they did not take every step that a reasonably diligent person would take to minimise potential loss to the company’s creditors.
To rebut wrongful trading claims and properly discharge their duties, it is useful for the directors to clearly to set out the basis on which they believe it is reasonable to continue trading and avoid insolvency at every board meeting. Any steps taken to increase income and reduce expenditures, which may include finding redundancies and terminating service agreements, should be highlighted. Reliance, placed on the continued support of the investor, should be genuine and not fanciful backing.
If the directors conclude there’s no reasonable prospect of avoiding insolvency, their decision as to what to do to minimise potential loss to creditors also needs to be carefully minuted to protect themselves against subsequent criticism.
The investor director should consider whether they need an indemnity from their appointer (i.e., the investor entity) to indemnify the director for any liability incurred in their role as director when acting on the instructions, or in the interest of, the investor.* Investors may resist indemnities and offer insurance instead, but directors are reminded that insurance is unlikely to be available for wrongful trading liability, although it may cover the costs of defending themselves.
* As the appointer may want to limit the indemnity to these circumstances, the director would say, “I need an indemnity to cover my role as a director, which is what you had me sign up for.”
The investor director should consider whether they need an indemnity from their appointor (i.e., the investor entity) to indemnify the investor director for any liability incurred in their role as director when acting on the instructions, or in the interest of, the investor.
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